World Economic Crisis – causes and solutions
The financial meltdown that started in 2008, which
originated in the subprime mortgage market in US housing sector ultimately
threatened the entire world economy and we have still not recovered from it
fully. The root causes are :
1.US government’s ambitions in promoting home
ownership among all sections of its citizens, for which government backed
financial giants Freddie Mac and Fannie Mae were created and subsidized. This
incentivized the private sector banks to dump the ‘toxic assets’ into the
willing hands of the government entities. Also tax concessions were given for
the incentivizing home loans to subprime categories, whom otherwise would not
have been serviced by the lenders.
2.The interest rates in US markets were artificially
held down to near 1 % levels from the years 2000 to 2004 (and even after) by
the US Federal Reserve Board with the objective of ‘pulling up’ the economy
from the recession caused by the dot com bubble collapsing in 2000. This
unleashed the mother of all credit booms as the real rate of interest was
higher than the rate set by Federal Reserve.
3. The US government budget deficits rose continuously
to fuel the unsustainable levels of spending for defense, social security and
for the Iraq and Afghan wars. US trade deficits (net of imports over export
revenues) too rose to alarmingly high levels. All these should have depreciated
the value of US dollar in an ideal currency market. But the exporting nations
like China, Japan, OPEC (which sells most of its oil to US) artificially propped
up the value of the US dollar (so as to help their export booms) by buying US
treasury bills limitlessly. If (a very big IF) this has not been done, US
dollar would have sunk like stone and hence the US consumer and government
spending would not have reaching these crisis levels. But as US dollar is the
reserve currency of the world and most of the international trade and
investments are done in dollars, this self correction of currency values that
is the basis of any undistorted market did not occur in currency markets of the
world.
4.The wall street banks are held as the prime villains
in this drama. But this is only partially true. They could act recklessly not
because of lack of regulations but mainly due to the unprecedented money supply
created due to the above three factors. The entire world was awash with
unsustainable money supply in those booming years.
5. Creation of the Euro currency in Europe was another
major blunder which exuberated the distortions to an ideal money market. The
corrective measures that come to play in a undistorted currency market (where
the value of a nations currency is determined by the inherent strength of its
economy, its budget deficits, inflation and interest rates) could not happen
within Euro areas as well as in US money markets.
The US and the world seem not to have learnt any
worthwhile lessons from this major crisis and in future similar booms and busts
will recur as public memory is short and economic illiteracy is widespread.
The corrective measures that should be put in place
now are :
11. Massive reduction in US budget deficits by reducing US military and
other expenditures. Closing of government backed housing loan mortgage institutions.
22. China and other Asian exporting nations should abandon (or at least
reduce) the distortions they create in artificially propping up the US dollar.
Especially the Chinese role in this is huge and unsustainable in the long run.
33. Euro currency should be abandoned in a calibrated manner or otherwise
the Euro area will collapse due to internal contradictions in the long run.
This will pull down the world economy when it occurs. Ireland and Spain suffer
needlessly due to Euro while basically they remain solvent and were growing
economies in the past.
44. All the nations should try to reduce their budget deficits and contain
unwanted and wasteful expenditures, especially military spending. (this is a
tall order and idealistic, but if it continues unabated then crisis will recur)
